Financial Ratios
Financial ratios are measures of your company's financial information to provide insight into how your company is performing. It is a way to analyze the financial transactions and give relevant meaning to the data. There are many financial ratios to measure different areas of your business's performance. This article will focus on a select few liquidity measures to demonstrate their use and how they can help you in the decision making process..
The current ratio is a measure of the company's liquidity. The company's current assets are divided by the company's current liabilities to arrive at the ratio. The company's current assets consist of cash, short term investments, accounts receivable, inventory, and other assets that are short term in nature. The company's current liabilities are accounts payable, accrued expenses, current portion of long term debt, and other obligations that are short term in nature. A ratio of one or greater is considered good and means that the company has enough liquid assets on hand to meet its current obligations. A ratio of less than one is viewed as less than good and means the company does not have enough liquid assets on hand to pay its current obligations.
The quick ratio is the same as the current ratio with one difference. The current assets exclude inventory and other current assets. This provides an even more precise measurement of the company's ability to meet it's current obligations with the liquid assets on hand, as inventory and other current assets do take some time to be converted into cash reserves.
The cash ratio is the same as the quick ratio with one difference. The current assets exclude accounts receivable, and only consist of cash, cash equivalents, and invested funds. This measurement provides insight into what liquid assets your company has on hand that can be used on a more immediate basis to pay your company' current liabilities. As some current assets, inventory and accounts receivable as an example, will take time to convert to cash, or in some circumstances, may not be converted to cash at all. This ratio provides the hardest look at what reserves your company has on hand to pay it's current obligations.
The use of financial ratios to provide greater insight into how your company is performing, can measure different areas of your company's financial performance, and give you valuable information, that can be effectively used in the decision making process to help you make your business the best it can be.
The article is general in nature, and not specific to any business, and the opinion of the writer. It does not intend to provide specific accounting advice, rather general information about the subject matter.